Low-Volatility Approach Working In EM ETFs

 |  Includes: EELV, EEM, EEMV, HILO, VWO
by: Tom Lydon


Why consider emerging market ETFs?

Emerging market stocks show attractive valuations.

Wary investors can consider low-volatility options.

By Todd Shriber & Tom Lydon

Investors that have a once bitten twice shy view of emerging markets exchange traded funds still have reasons to consider developing economies.

Recent strength in the emerging markets complex confirms as much. Over the past 90 days, the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO) and the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM), the two largest emerging markets ETFs by assets, are each up more than 9% while the S&P 500 is higher by 3.9% and the iShares MSCI EAFE ETF (NYSEARCA:EFA) is up 2.3%. Said S&P Capital IQ in a new research note:

According to the International Monetary Fund's April 2014 forecasts, the non-developed market growth slowed in 2013. However we think investors should still be pleased with the expected above-average 7.5% growth for China, 6.5% for the Philippines, 6.4% for India, and 5.2% for Malaysia. Even the 3.7% for South Korea and 3.1% for Poland and Taiwan look favorable relative to the 2.8% for the United States and 1.2% for the advanced Euro area.

Compelling valuations have played a pivotal role in luring investors back to EEM, VWO and other emerging markets ETFs. EEM has pulled in $4.77 billion in new assets this quarter, making it the second-best ETF of any type in terms of second-quarter inflows. VWO has added $805 million in the current quarter.

Those inflows are even more impressive when considering some major pension funds significantly reduced their exposure to EEM and VWO during the first quarter. S&P Capital IQ rates VWO overweight and EEM marketweight. According to the research firm.

Further from a valuation perspective, according to Bloomberg data, the Emerging Markets Index was valued at a P/E of 11 times 2014 consensus estimates, a 33% discount to the EAFE Index's 16. Looking back on a monthly basis since 1995, the Emerging Markets Index historically traded at a 32% discount to the more developed international market.

Skittish investors that have opted for a low-volatility approach to emerging markets ETFs have also been rewarded. For example, the iShares MSCI Emerging Markets Minimum Volatility ETF (NYSEARCA:EEMV) and the PowerShares S&P Emerging Markets Low Volatility Portfolio (NYSEARCA:EELV) are each about 8% over the past three months.

EEMV, rated marketweight by S&P Capital IQ, is conservatively postured at the country level. China is the ETF's largest country allocation at 19%, but Taiwan and South Korea, two of the lowest beta emerging markets, combine for over 28% of the ETF's weight.

Additionally, India and Russia, two of the most volatile emerging markets, combine for less than 3%. Brazil, another developing economy rarely short on equity market volatility, is just 6.25% of the ETF's weight.

EELV is similar to the U.S.-focused PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA:SPLV) in that the former's components are evaluated by trailing 12-month volatility.

EELV is even heavier on Taiwan and South Korea than EEMV with those countries combining for over 42% of the PowerShares offering's weight. Malaysia, another low beta developing market, occupies a 15% weight in EELV, nearly double the weight EEMV gives to that country. Said S&P Capital IQ:

EELV and EEMV have net expense ratios of 0.29% and 0.25%, respectively. However, just because these two ETFs aim to hold lower risk stocks does not make them immune to losses, as both were in the red in2013.

The research firm also rates EELV marketweight.

iShares MSCI Emerging Markets Minimum Volatility ETF

Tom Lydon's clients own shares of EEM and EFA.

Disclosure: I am long EEM, EFA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.